Energy Storage Systems and Variance Swaps

I. Definitions

There are, I think, interesting conceptual connections between symmetric energy assets (e.g. BESS) and variance swaps. I’ll reflect on these connections over a series of posts of which this is the first. I’m particularly excited about this series, because it gives me a chance to step back into my research career in mathematical finance at least half of which was dedicated to variance swaps. I hadn’t expected this connection to arise, and serendipitous connections are often the most rewarding.

The theory of variance swaps and volatility in the capital markets is very mature and the aim is to see if we can use some of this maturity to inform our thinking about symmetric energy assets. Let’s start with definitions.

If you’re used to financial mathematics then volatility has a specific meaning. To create connections between variance swaps in the capital markets and ideas in the energy domain we will need to relax our definition of volatility to begin with.